Cheap Stocks – Not Penny Stocks, But Almost
The basic definition of cheap stocks is the low level of stock prices and how much it would cost to buy them. The expression ‘cheap stock’ however could indicate the relative value between share price and the company’s intrinsic worth. How closely stock prices track the business performance of the company might provide better indications of the stock value.
It is not possible to tell from market prices alone whether a stock is cheap. Stocks under 10 dollars are not automatically low cost stocks. The greater the growth potential of a stock, the more likely it will have high price. On the other hand, if a cheap stock produces bad fundamental reports, it could still be considered expensive. There are better ways of how to invest in penny stocks.
Price To Earnings Ratio (P/E)
When selecting penny stocks to buy, stock prices can be compared with per-share company earnings. Whether a stock is expensive or cheap depends on the level of its price-to-earnings ratio. The smaller the price-to-earnings ratio, the cheaper the stock, and vice versa. For stocks that have posted large earnings, the relatively high stock prices may prove to be cheap if the price-to-earnings ratio is still low. The relatively low price stocks that have reported small earnings may turn out to be expensive if the price-to-earnings ratio is still high.
Cheap Stocks That Were Big Once
Investors who focus on nominal share price alone are exposing themselves to great risks. Most stocks with a cheap share price tend to be of a lesser quality.
What about stocks on the NYSE that trade for $5, for example? On major exchanges stocks under $5 come with all the risks of penny stocks. Right now some of the largest market cap stocks in the single digits include the battered Lloyds Banking Group (LYG), Mitsubishi UFJ Financial Group (MTU), Nokia (NOK) and Sprint Corp. (S). All had troubles in the past years. Sure, they might go up again, but they also might never reclaim past valuations. Geniuses like Steve Jobs and iconic companies like Apple are extremely uncommon among $5 stocks.
You don’t have to have large capital to invest in high priced stocks. Let’s say you had $120 to invest a year ago. You could have bought a single share of Tesla Motors (TSLA) at $120 in November, 2013 and made 133% gains 9 months later.
Benjamin Graham – The Cheap Stock Explorer
When identifying the best cheap stocks, one of Graham’s strategies focused on finding companies trading below their “Net Current Asset Value” (NCAV). In cases where market capitalization is less than net current assets, you may have found a bargain.
Graham preferred companies trading at less than 2/3 of their NCAV, which allowed a greater margin of safety. A reliable research from 1988 found that buying these companies, then selling two years later beat the market by 24 percent. Word of warning though: companies may be trading at these levels for good reason. They may be in trouble, so further analysis of such companies is necessary.
This strategy demands patience. Even if you uncover a true gem, it may take a long time for the share price to reflect the company’s true value. You may find a company with undervalued assets, but you should also look for growth potential. Look for companies who have positive earnings (or have the potential to increase earnings in the future), lots of cash, and in-demand products.
There are not many well-known companies meeting these criteria. The large majority will be small companies – maybe even penny stocks – with market caps below $100 million. Analysts typically don’t follow these companies, institutions don’t own them, and they don’t generate much press.